The U.S. Tax System: The TCJA’s attempt to move from Worldwide to Territorial

I wanted to take the chance to break down some of the big picture topics mentioned in the article, The Expansion of “United States” Taxpayers: How the TCJA Drags Unassuming Foreign Companies and Individuals under its Scope. However, to set the stage, it is important to understand how the US has historically operated as a worldwide tax system and its recent move towards a territorial one. So, this blog post will introduce you to these two variations of tax systems used internationally and give you an overview on how the new US regime fits into the mix. Please note that both of these systems apply only to income tax structures, and not to other tax arrangements such as a consumption tax structure.

Worldwide Taxation

In a traditional worldwide tax regime, the country to which you are a resident of applies a tax to all of your income regardless of where it was sourced. For example, if you are a US resident and have income from the US and from Australia, then under this system, the US would tax you on both your US-sourced and your Australia-sourced income. One thing to note here is that the term “resident” may not align with your common sense understanding of the word. Instead, most tax regimes base residency on whether you qualify as that country’s resident under statutory tests; which, as you could guess, can get quite complicated depending on the country and your particular living circumstances.

Territorial Taxation

On the other hand, a country using a traditional territorial tax system will only tax you on income sourced from operations located within its geographical boundary, or “territory.” So, using the previous example, if you are a US resident and have both US and Australian income, then the US would only tax you on your US income. While this appears to be the more attractive option for taxpayers, it is important to note that most countries with this system have other taxes in place to “make up for” the decrease in income, such as a supplementary consumption tax.

The U.S.’s New “Territorial” System

Under the Tax Cuts and Jobs Act (TCJA), the overarching system of US taxation has shifted from a worldwide one to territorial one. However, this is not a complete shift as the TCJA still allows the government to tax foreign-derived income of US residents in certain scenarios. One scenario is where a US resident is a shareholder of a controlled foreign corporation (CFCs). Thus, the US’s tax system might be said to hit somewhat of a middle ground between worldwide and territorial taxation. A middle ground that can weigh more heavily in one direction based on your particular circumstances.

Stay up to date with our blog posts as we navigate through this shift and be sure to read our article for a comprehensive outlook on the Tax Cuts and Jobs Act of 2017.